Sec. & Exch. Comm'n v. Coinseed, Inc.

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SECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. COINSEED, INC., et al., Defendants.

No. 21-CV-01381 (PGG)(SN)

United States District Court, S.D. New York

January 30, 2023

REPORT AND RECCOMENDATION

SARAH NETBURN, United States Magistrate Judge

TO THE HONORABLE PAUL G. GARDEPHE:

The Honorable Paul G. Gardephe referred this matter to my docket for an inquest on damages following an entry and order of default against defendants Coinseed, Inc. (“Coinseed”) and Delgerdalai Davaasambuu (“Davaasambuu”). Plaintiff Securities and Exchange Cormnission (“SEC”) submitted a Proposed Findings of Fact and Conclusions of Law (“Proposed Findings”). Defendants failed to respond.

The SEC requests that the Corut order Coinseed and Davaasambuu to pay disgorgement, respectively, in the amounts of $28,282 and $113,128, plus pre-judgment interest. The SEC further requests that each defendant pay a civil money penalty in the amount of $141,410. Because the SEC has provided the Court with a sufficient basis on which to award damages, the Court recommends an award of the relief requested, as modified by this report and recommendation.

BACKGROUND

I. Factual Background

In light of Defendants' default, the SEC's properly-pleaded allegations are accepted as true, except those relating to damages. See Cotton v. Slone, 4 F.3d 176, 181 (2d. Cir. 1993). The following findings of fact are based on the complaint's allegations regarding liability.

Coinseed is a Delaware corporation incorporated in November 2017. Davaasambuu is Coinseed's founder and CEO, possesses an 80% ownership interest in the company, and wrote the code underlying its website and application.

Coinseed's principal product was a mobile application that allows users-after linking the app to a payment card or bank account-to invest money by “rounding up” purchases to the nearest whole dollar amount and then depositing the difference in an investment portfolio, whose assets the user could select. Coinseed also allowed users to view each other's portfolios and corresponding returns and encouraged users to convert their portfolios to match those with the highest rate of return. When a user opted to convert their portfolio to replicate another, Coinseed assessed a fee of 1% of the user's portfolio's value.

To raise capital, Coinseed offered and sold digital tokens (that it named “CSD”) in two rounds from December 2017 to January 2018, and March 2018 to May 2018. Davaasambuu wrote the code underlying CSD and prepared whitepapers describing Coinseed's business plan, including the sale of CSD to fund Coinseed's marketing and growth. The whitepaper also promised prospective CSD purchasers a regular distribution of profits, specifically stating that around the close of the second round of sales in May 2018, and on a monthly basis thereafter, CSD holders would be entitled to a pro-rata share of 50% of the revenue generated by Coinseed's 1% portfolio conversion fees. According to Defendants' public filings, they raised at least $141,410 from hundreds of individual investors through the sale of CSD. See ECF No. 5414 at 35. Coinseed never registered CSD as a security with the SEC.

II. Procedural Background

On February 17, 2021, the SEC brought this action against Coinseed and Davaasambuu alleging violations of Sections 5(a) and (c) of the Securities Act of 1933 (“Securities Act”). See 15 U.S.C. §§ 77e(a) and (c). The complaint was served on Coinseed on February 26, 2021, and Davaasambuu waived service on March 29, 2021. Counsel entered an appearance on behalf of Defendants on April 5, 2021, but moved to withdraw on April 22. On May 7, 2021, the Court held a conference to discuss the motion. Despite being directed to attend, neither defendant appeared at the conference, and later that day the Court granted the motion. The Court's order also directed Defendants to answer or otherwise move against the complaint by June 4, 2021, and Defendant Coinseed to retain counsel by June 11. On June 18, 2021, neither Defendant had made any filing, and the Court directed the SEC to move for default judgment.

On June 23, 2021, the Clerk of Court issued certificates of default as to both Defendants, and on July 6 the Court issued an order to show cause, with a hearing date of August 19. Defendants did not respond to the order or attend the hearing, and on August 23, 2021, the Court entered default judgment against them and enjoined them from further violations of the Securities Act.

That same day Judge Gardephe referred this matter to me for an inquest on damages. On August 24, 2021, I directed the SEC to file submissions supporting its request for a final judgment against defendants. The Order notified the parties that, absent a request from either side that the Court hold a hearing, the Court would conduct its inquest regarding damages based solely upon the parties' written submissions. The SEC submitted the Proposed Findings and an affidavit seeking to recover a combined total disgorgement of $141,410 plus pre-judgment interest, along with a civil monetary penalty of $141,410 per defendant. The Court gave Defendants until October 23, 2021, to respond, but they did not. Neither party has requested a hearing on the issue of damages.

DISCUSSION

The Court of Appeals for the Second Circuit succinctly set forth the procedural rules applicable to the entry of a default judgment in City of New York v. Mickalis Pawn Shop LLC:

“Federal Rule of Civil Procedure 55 is the basic procedure to be followed when there is a default in the course of litigation.” Vt. Teddy Bear Co. v. 1-800 Beargram Co., 373 F.3d 241, 246 (2d Cir. 2004). Rule 55 provides a “two-step process” for the entry ofjudgment against a party who fails to defend: first, the entry of a default, and second, the entry of a default judgment. New York v. Green, 420 F.3d 99, 104 (2d Cir. 2005). The first step, entry of a default, formalizes a judicial recognition that a defendant has, through its failure to defend the action, admitted liability to the plaintiff.... The second step, entry of a default judgment, converts the defendant's admission of liability into a final judgment that terminates the litigation and awards the plaintiff any relief to which the court decides it is entitled, to the extent permitted by Rule 54(c).

645 F.3d 114, 128 (2d Cir. 2011). The Court of Appeals has noted that, while the “typical Rule 55 case [is one] in which a default has entered because a defendant failed to file a timely answer,” Brock v. Unique Racquetball & Health Clubs, Inc., 786 F.2d 61, 64 (2d Cir. 1986), “a district court is also empowered to enter a default against a ‘defendant [that] has failed to . . . otherwise defend.'” Mickalis Pawn Shop, 645 F.3d at 129 (quoting Brock, 786 F.2d at 64). Here, Defendants failed to file an answer or respond at all to the SEC's complaint, and Coinseed failed to defend by not obtaining new counsel once its former counsel withdrew. See Jones v. Niagara Frontier Transp. Auth., 722 F.2d 20, 22 (2d Cir. 1983) (noting that a corporation cannot proceed pro se). See also Mickalis Pawn Shop, 645 F.3d at 130 (holding that entry of default was proper where a limited liability company failed to obtain counsel despite the court's warning that such failure would result in default).

I. Liability

Courts evaluating damages in a default context first look to the complaint to determine whether the plaintiff has established aprimafacie case for recovery. See Lenard v. Design Studio, 889 F.Supp.2d 518, 528 (S.D.N.Y. 2012) (the court must first determine whether the allegations in the complaint were sufficiently pleaded to establish liability); Eurosteel Corp. v. M/V Koggegracht, No. 01-cv-7731 (DLC), 2003 WL 1872652, at *1 (S.D.N.Y Apr. 11, 2003) (finding that a report and recommendation correctly concluded that plaintiff had established a prima facie case for recovery).

The SEC asserts claims for sale of an unregistered security in violation of 15 U.S.C. § 77e(a) and failure to register a security in violation of 15 U.S.C. § 77e(c). The Securities Act defines a security as, inter alia, an “investment contract.” 15 U.S.C. § 77b(a)(a). An “investment contract” is a “contract, transaction or scheme whereby a person invests [their] money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party.” S.E.C. v. W.J. Howey Co., 328 U.S. 293, 298-99 (1946). “The three-prong Howey test for determining whether a particular scheme is an investment contract is whether the scheme involves (1) an investment of money; (2) in a common enterprise; and (3) with the expectation of profits to be derived from the efforts of a third-party.” Rocky Aspen Mgmt. 204 LLC v. Hanford Holdings LLC, 230 F.Supp.3d 159, 163 (S.D.N.Y. 2017) (internal quotation marks omitted). 15 U.S.C. § 77e(c) makes it unlawful to sell any security without first filing a registration statement with the SEC.

The complaint alleges that Defendants, without filing a registration statement, advertised and sold a token which entitled its purchasers, with no further action required, to a portion of Coinseed's future earnings; Defendants also explicitly told consumers that the proceeds from the token sales would fund Coinseed's development. Accordingly, the complaint contains sufficient facts to plead that Defendants sold an unregistered security. Indeed, Judge Gardephe has already granted the SEC an injunction against Coinseed on this claim. And because Defendants never registered CSD with the SEC, the allegations in the complaint also establish a valid claim of failure to register a security.

II. Inquest on Damages

Once liability is established, the sole remaining issue before the court is whether the plaintiff has provided...